Carbon Protectionism?

Abstract: This study examines the market reactions and valuation implications of the Carbon Border Adjustment Mechanism (CBAM) adopted by the European Union (EU). The CBAM is the world's first carbon border import tax aimed at addressing carbon leakage and promoting a transition to a low-carbon economy. Using an event study methodology and regression analysis, we analyze the response of stock prices of EU-based firms in affected industries to CBAM legislation announcements. Our findings indicate that the market reactions to CBAM announcements were limited, with only a few events showing statistical significance. Regression analysis reveals a uniform effect across affected industries' cumulative abnormal returns (CARs), while the relationship between the share of sales in the EU and CAR remains inconclusive. The results suggest that the positive market sentiment towards protectionist trade policies, as anticipated by classical trade theory, may not be fully realized in the context of a carbon emission-targeted import tariff. Assuming the efficient market hypothesis holds (EMH), we provide three possible explanations for these findings; i) the evaluation of the CBAM in conjunction with the EU's commitment to the Emissions Trading System (ETS), ii) investor considerations of political aspects such as trade wars and lobbying activities, and iii) issues related to implementation and accounting complexities related to the policy.